Will Higher Interest Rates Impact Stocks?

Interest rates have hit record lows and remained low for several years in an effort to help boost the economy, but increasing interest rates are likely at some point this year. As an investor you may wonder how this will affect stock prices and what types of stocks might look more promising in this scenario.

How Interest Rates Affect Stocks

Many investment professionals are saying that when the Federal Reserve decides to raise short-term interest rates it will be a good thing. The Federal Reserve won’t raise interest rates until they feel economic recovery is solid enough for companies to feel like they are able to raise prices again and grow their business.

Investment firms have also pointed out that in the past stocks have done well during periods where interest rates were rising. While it depends on the time measured and how the interest rate policy is defined, on average they’ve seen stocks gaining 8% to 10% annually. Historically the highest returns occur when low level interest rates rise gradually during periods when inflation rates are minimal. This just happens to be the same conditions we’re experiencing now, which could mean good news for investors.

While history may repeat itself to some degree, don’t over study a similar set of circumstances from the past and expect the financial history to repeat itself in the exact same way. The rise in interest rates and the overall monetary policy of the Federal Reserve is just one of the many factors that can influence the stock market, so this is just one of the many factors you’ll need to consider when making any investment decisions.

Possible Investments To Consider

That said, there are a few specific sectors that can benefit from rising interest rates and improved job markets. One of these is the insurance sector. Insurance companies are able to float the money they are holding in investments. They receive premiums from policyholders, but they are able to hold on to those premiums for a while because there is a lag between the time they collect the premium and the time they may have to pay out for a claim. With a large enough business they don’t need high interest investments to generate significant income, instead they usually hold fixed-income securities.

Another sector that may reap the benefits of rising interest rates includes banking institutions that have strong lending operations. Specifically look for banks that have conservative lending strategies and better asset qualities. As mortgage rates rise banks are able to gain larger profits. This is especially true when the gap between the money they are paying on interest savings and the amount they are making on mortgage lending widens.

Allowing a rise in interest rates likely means confidence in the job market. If the job market remains steady, or better yet if it grows, this could mean bigger profits for large payroll processing companies. These companies often receive funds from clients a few days before they have to cut checks to employees. Similar to insurance companies, this allows them to earn more on the money they are holding or floating, which will likely help them increase profits.